Common Examples of IRS Foreign Noncompliance Penalty Abatement

Common Examples of IRS Foreign Noncompliance Penalty Abatement

In recent years, the Internal Revenue Service has significantly increased enforcement of foreign reporting non-compliance penalties. For example, if a U.S. Taxpayer fails to report foreign accounts, assets, investments, trusts, or entities to the IRS they may become subject to fines and penalties. And, since there are many different types of international information reporting forms that a Taxpayer may have to file each year, the IRS has many opportunities to penalize the Taxpayer for foreign reporting non-compliance. Some of the more common international reporting forms include the FBAR, Form 8938, and Form 5471. Once a Taxpayer has received a penalty, there are specific protocols they must file to try to get that penalty abated (‘waived’). Noting, in late 2024 the IRS signaled that it would be changing course and no longer automatically assessing Taxpayers for Form 3520 penalties (hopefully this will extend to other foreign reporting penalties as well). Let’s take a look at some common examples of penalty abatement.

*For all examples, please note that the Taxpayers are U.S. persons for tax purposes who have not made any treaty elections to be treated as a Non-Resident Alien (NRA). Also, these examples are for illustrative purposes only and Taxpayers should consult with a Board-Certified Tax Law Specialist if they have specific questions about their reporting requirements and not rely on this article for legal advice.

Pre-IRS Foreign Penalty Assessment

Taxpayers who have not yet been penalized may be able to circumvent the abatement process by avoiding penalties in the first place (assume all Taxpayers in these examples are non-willful).

• • • Example:  Scott is a U.S. Citizen who has bank accounts in a foreign country. The total value of the accounts are $40,000 and he has no unreported income. Scott may qualify for the Delinquent FBAR Submission Procedures and avoid any penalties for the non-compliance.

    • Example: Miranda is a Lawful Permanent Resident who has investment accounts in three foreign countries for a total value of $600,000. Miranda lives outside of the United States for more than 350 days a year. She may qualify for the Streamlined Foreign Offshore Procedures (SFOP) and avoid any penalties for her noncompliance.

    • Example: Michael is a Lawful Permanent Resident who also has investment accounts in three foreign countries for a total value of $550,000. Michael lives in the United States and therefore he may qualify for the Streamlined Domestic Offshore Procedures (SDOP) and may have to pay a 5% penalty.

• • • Example: Michael’s brother is a Lawful Permanent Resident who also has investment accounts in three foreign countries for a total value of $550,000. Michael lives in the United States and filed his returns through a CPA who claimed to be an expert who specializes in international tax and foreign account compliance. He told Michael that since he was not a U.S. Citizen, he did not have the file, but that is not correct. While Michael qualifies for SDOP, he may also qualify to make a reasonable cause pre-assessment submission to try to avoid penalties.

FBAR Penalty Assessment

Unlike most other international information reporting forms, the FBAR is not an IRS form but rather a FinCEN form covered under Title 31 of the U.S.C. (Money & Finance) and not Title 26 (Internal Revenue Code). As a result, the penalty abatement strategy is different than it is for other international reporting forms.

• • • Example: David received an FBAR penalty and a 30-day notice to file an appeal with the IRS Independent Office of Appeals. David challenges the penalty but loses and then requests a collection due process hearing. Unfortunately, David is not eligible for Collection Due Process to challenge an FBAR penalty.

    • Example: Peter received an FBAR penalty and wants to challenge in Tax Court, so he files a petition with the Tax Court to challenge the FBAR penalty. Unfortunately, Peter is not eligible to challenge an FBAR penalty in Tax Court and his petition is denied for lack of jurisdiction.

• • • Example: Matthew is in assessed enough bar penalty and loses at appeal. Matthew wants to challenge the penalty, so he files a lawsuit in the Federal Court of Claims but does not want to pay the penalty amount first as is typically required under the Flora rule. The government challenges Matthew and claims he has to pay the penalty first, but the government’s challenge is rejected because under the case of Mendu, Taxpayers do not have to prepay the penalty in the federal court of claims in order to challenge and FBAR Penalty (since they do not get the opportunity to go to Tax Court first).

IRS International Reasonable Cause Penalty Abatement

For most international information reporting forms, Taxpayers can abate the penalty if they can prove reasonable cause. Reasonable cause requires the Taxpayer to meet certain requirements to prove that it was justified for them not to have filed the form correctly and that, as a result, the penalty should be abated.

• • • Example:  Denise is a U.S. person who received a large gift from her grandmother who was a non-resident alien and lives in a foreign country. Denise files her Form 3520 late with a reasonable cause statement and is assessed a 25% penalty because the original agent does not believe that reasonable cause was met. Denise files an appeal with the IRS Independent Office of Appeals and explains that this was the first time (distinct from the first time penalty abatement) she was required to file, she is otherwise tax compliant, and she has not been penalized before. Denise may qualify for a penalty abatement.

    • Example: Ronald is the owner of a foreign trust that he owned before becoming a U.S Person. Ronald went to his CPA who explained to him that because he did not receive any distributions, he was not required to file any forms. Ronald later learned that as the owner of the foreign trust he is still required to file Forms 3520 and 3520-A. The CPA filed the form late, and Ronald was penalized.  Ronald hires an attorney to submit a reasonable cause letter explaining the facts of the case and the IRS agrees to abate the penalty.

    • Example: Melissa is a U.S. citizen who is a 15% owner of a foreign company (non-CFC). She does not receive any distributions and files all of her tax returns timely. She had misunderstood that a Taxpayer does not have to be a ‘U.S. Shareholder’ of a Controlled Foreign Corporation to have to file a Form 5471. Melissa files the form late and is penalized. As part of her protest letter, she explains that it is a small family company, she does not receive any income, she files all of her tax returns timely, and she does not have any other foreign reporting that is required of her (such as FBAR or FATCA Form 8938). In this situation the IRS may agree to abate the penalty for reasonable cause.

• • • Example: Dean is a single, U.S. citizen who previously worked in a foreign country and has a pension account worth $900,000 and a foreign bank account worth $3000. Dean was unaware that foreign pensions were required to be reported so he did not file a Form 8938 or FBAR. Dean was penalized for not filing Form 8938 and received a CP15 notice. He submitted a protest explaining the facts above and that when in prior years the bank account was above $50,000 on the last day of the year, he did file the Form 8938. The IRS accepts his submission and his penalties are abated.

The Tip of the Iceberg

The goal of this article is to help clarify some of the basics of foreign non-compliance reporting penalties. Reporting foreign assets to the U.S. tax authorities can be very complicated, especially when it involves additional items such as foreign life insurance policies, foreign corporations, foreign partnerships, and transactions between U.S. persons and foreign companies. Taxpayers should try to stay in compliance if they are already in compliance or should consider getting into compliance if they have not properly filed the necessary reporting forms if for no other reason than the fact that the IRS has made offshore compliance a key enforcement priority and has been issuing fines and penalties for non-compliance. 

Late Filing Penalties May be Reduced or Avoided

For Taxpayers who did not timely file their FBAR and/or other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist Taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.

Current Year vs. Prior Year Non-Compliance

Once a Taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, Taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.

Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)

In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties. 

Need Help Finding an Experienced Offshore Tax Attorney?

When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for Taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting. 

*This resource may help Taxpayers seeking to hire offshore tax counsel: How to Hire an Offshore Disclosure Lawyer.

Golding & Golding: About Our International Tax Law Firm

Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure. 

Contact our firm today for assistance.